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Lecture 6

SGMA 591 Lecture 6: 6. Corporate Level Strategy—Vertical Integration
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10 Pages
84 Views
Spring 2016

Department
Strategy and Global Management
Course Code
SGMA 591
Professor
Ayesha Malhotra
Lecture
6

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Corporate Level StrategyVertical Integration6/6/2016 7:04:00 PM
Why do we have firms? Why not pure contracting?
Explanations:
o Entrepreneur bears risk; “residual claimant” (equity)
o Transaction costs
Outline
What is corporate strategy?
Key questions and topics
o Vertical Integration, product, and geographic diversification
Classifying vertical integration
The role of transaction costs in vertical scope
o Contributions of Nobel Prize Winners to our understanding
Costs and benefits of vertical integration
A broader look at vertical relationships
o Key questions and recent trends
Corporate Strategy
Corporate Strategy is the actions/decisions taken to gain Strategic
Competitive Advantage (SCA), through a mix of business activities,
spanning one or more or the following:
o Value chain stages for a given product/service
o Diverse product markets
o Diverse geographic markets
Decisions about the boundaries of the firm
Determines where the firm competes
find more resources at oneclass.com
find more resources at oneclass.com
o Product scope: how specialized firm is in terms of range of
products it supplies
o Vertical scope: range of vertically linked activities firm
encompasses (how much of value chain it is involved in)
o Geographical scope: geographical spread of activities of
firm
Key Questions
Which activities and businesses should the firm be in?
How should the corporate office manage the portfolio of business
units?
o How to allocate resources?
o How to add value?
Managing the Corporate Portfolio
Key Topics
Vertical integration
Product diversification
Acquisitions
Restructuring
International Strategy
Basic Corporate Goal:
o V(C) > V(B1) + V(B2)
Vertical Integration (VI)
find more resources at oneclass.com
find more resources at oneclass.com
Classifying vertical integration—doing more things “in house”; firm’s
ownership of vertically related activities
o Backward vs. forward
Backward example: Zara manufactures its own clothes
Ownership and control over production of its
inputs
Forward example: Apple has its own retail stores
Ownership and control of activities previously
undertaken by customers
o Full vs. Partial
i.e. 50% in-house; 50% outsource
The question of “markets” versus “hierarchies (firms)
o Hierarchies = firms because you have a hierarchy of control in
them
Traditional, neoclassical economics
o Adam Smith’s “invisible” hand, i.e. role of “market
mechanism”
o Neglects “visible” hand of firms, i.e., “administrative
mechanism”
Focus on production costs
Discusses the entrepreneur, risk, and uncertainty
Pros:
o More control
o Can lower transaction costs
Cons:
o Can get away from your strengths
o Stretch yourself too thin
Transaction costs the costs to acquire inputs from markets and
to sell their output on markets
o i.e. negotiating, making contracts, monitoring
o Greater transaction costs = firm more likely to extend its
corporate scope
o Transaction-specific components more likely to be made in
house than purchased in external market
find more resources at oneclass.com
find more resources at oneclass.com

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Description
find more resources at oneclass.com Corporate Level Strategy—Vertical Integration 6/6/2016 7:04:00 PM Why do we have firms? Why not pure contracting?  Explanations: o Entrepreneur bears risk; “residual claimant” (equity) o Transaction costs Outline  What is corporate strategy?  Key questions and topics o Vertical Integration, product, and geographic diversification  Classifying vertical integration  The role of transaction costs in vertical scope o Contributions of Nobel Prize Winners to our understanding  Costs and benefits of vertical integration  A broader look at vertical relationships o Key questions and recent trends Corporate Strategy  Corporate Strategy is the actions/decisions taken to gain Strategic Competitive Advantage (SCA), through a mix of business activities, spanning one or more or the following: o Value chain stages for a given product/service o Diverse product markets o Diverse geographic markets  Decisions about the boundaries of the firm   Determines where the firm competes find more resources at oneclass.com find more resources at oneclass.com o Product scope: how specialized firm is in terms of range of products it supplies o Vertical scope: range of vertically linked activities firm encompasses (how much of value chain it is involved in) o Geographical scope: geographical spread of activities of firm Key Questions  Which activities and businesses should the firm be in?  How should the corporate office manage the portfolio of business units? o How to allocate resources? o How to add value? Managing the Corporate Portfolio Key Topics  Vertical integration  Product diversification  Acquisitions  Restructuring  International Strategy  Basic Corporate Goal: o V(C) > V(B1) + V(B2) Vertical Integration (VI) find more resources at oneclass.com find more resources at oneclass.com  Classifying vertical integration—doing more things “in house”; firm’s ownership of vertically related activities o Backward vs. forward  Backward example: Zara manufactures its own clothes  Ownership and control over production of its inputs  Forward example: Apple has its own retail stores  Ownership and control of activities previously undertaken by customers o Full vs. Partial  i.e. 50% in-house; 50% outsource  The question of “markets” versus “hierarchies (firms) o Hierarchies = firms because you have a hierarchy of control in them  Traditional, neoclassical economics o Adam Smith’s “invisible” hand, i.e. role of “market mechanism” o Neglects “visible” hand of firms, i.e., “administrative mechanism”  Focus on production costs  Discusses the entrepreneur, risk, and uncertainty  Pros: o More control o Can lower transaction costs  Cons: o Can get away from your strengths o Stretch yourself too thin  Transaction costs – the costs to acquire inputs from markets and to sell their output on markets o i.e. negotiating, making contracts, monitoring o Greater transaction costs = firm more likely to extend its corporate scope o Transaction-specific components more likely to be made in house than purchased in external market find more resources at oneclass.com find more resources at oneclass.com  Costs of corporate complexity – extending boundaries of firm can eliminate transaction costs, but internalizing transactions makes the firm more complex Nobel Prize Winner: Coase (1937)  Insightful question o Why do we have “islands of conscious power in this ocean of unconscious cooperation, like lumps of butter coagulating in a pail of buttermilk?  Basically asking why we need firms; why can’t people just work together  Market transaction costs explain the “Nature of the Firm” o Costs of searching, negotiating, and drawing up contracts, monitoring subsequent behaviour, and enforcing contract provisions o Firms have the benefit of authority and “fiat” over their employees  Firms have some implicit authority—administrative authority o Costs of transacting with buyers/suppliers help explain why we have firms  An activity will be internalized if: o Its transaction costs are greater than the administrative costs of internalizing it How Do Transaction Costs Explain Vertical Integration?  Williamson (1975) – Nobel Prize in 2009  Key assumptions about human behaviour o Bounded rationality: results in incomplete contracting  Human beings want to be rational in their decision making, but have biases; take shortcuts; etc.— limitations of human brain o Opportunism: results in false promises, holdups, cutting corners, etc.  Human beings have a tendency to be opportunistic; take advantage of other people
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